Ch 8 Capital Assets.docx

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School

University of Toronto St. George

Department

Rotman Commerce

Course

RSM219H1

Professor

Martin Ralph

Semester

Winter

Description

Ch 8 Capital Assets 10/04/2013 12:02:00 PM
Includes: land, real estate, buildings, equipment, vehicles, computers,
patents, and so on that companies need to carry out operations
-Requires a substantial mortgages or debt to finance them
Objectives:
-Users anticipate the future outflows of cash to replace them
-Methods a company uses to depreciate its assets (on statement of
earnings)
-Future benefit
- Cash received over several future periods
Capital Assets Recognition
-The company has the right to use it and a transaction has occurred
1) ° Value in use -the future value represented by the cash that will be
received from the sales of products and services.
2) ° Residual value : Capital Assets’ disposal Value
How are C.A. valued?
1) Historical Cost:
- The original cost is recorded at the time of acquisition. Changes in the
market value are ignored.
- When it is used, its cost is expensed using a depreciation method. M.V. is
only recognized when it is sold.
- gain or loss on sale depends on the difference between the proceeds form
the sale and the net book value at the time of sale
- ° Net book value/ carrying value/ depreciation cost is the original cost less
the portion that has been charged to expense in the form of depreciation.
2) Market value
a. Replacement Cost (Buy)
° The amount that would be needed to acquire an equivalent asset
-Replacement cost and the depreciation expense have a positive
relationship
-The gain and loss is determined by the difference between the
proceeds from the sale and the depreciated replacement cost (price
at sale)
b. Net Realizable Value (Sell) -Assets are recorded at the amount from converting them to cash,
from selling them
-Depreciation is based on the NRV and is adjusted each time the
asset is re-valued.
- The G & L will be small
Canadian Practice: Historical Cost
° Net Recoverable Amount: the total of all the future cash flows related to
the asset, without discounting them to PV (an asset cannot be valued at
more than the NRA)
-If it carrying value > net recoverable amount, the carrying value must be
written down must be written down and the difference recognized as an
impairment loss.
° Capitalized Costs
- Any cost that is necessary to acquire the asset and get it ready for use:
Purchase price,
Direct taxes on the purchase price,
Interest cost,
Legal costs associated,
Shipping or transportation costs,
Preparation and set up costs…
-The purpose is to match the depreciation costs to the revenues that are
generated while the assets are being used.
-Land is a unique asset, its cost does not depreciate. Assigning costs to it
means that costs will remain on the statement of financial position forever
not the statement of earnings
*Companies would like to expense as many costs as possible in order to
reduce their taxable income and save on taxes. Capitalizing costs have to be
waited until the assets are depreciated before the costs can be deducted.
° Basket Purchase
-Acquiring several assets in one transaction
1) Each important component must be reported separately on the statement
of financial position; 2) Assets that have different rate of depreciation have to be recorded
separately in the accounts
3) some assets that don’t depreciate at all
Assets Fair Value % Purchase $ Allocated Cost
Land 250,000 25% 880,000 220,000
Timber 750,000 75% 880,000 660,000
1,000,000 880,000
-The F.V. of the land is 25% of the total F.V. -> 25%*880,000 is recorded in
the land account, 660,000 is recorded in the timber account
° Interest Capitalization
-the interest paid on the loan that finances the acquisition of a large C.A.
- the interest costs can only be capitalized until the C.A is compete and
ready for use
- For assets that are purchased, interest costs are not capitalized since the
time of acquisition is too short.
Deprecation Concepts
*Because the asset is expected to help generate revenue over multiple
periods, companies don’t show the entire cost as an expense in the period of
acquisition. Matching the cost and revenue results in a measurement of net
profit or loss during those periods.
-Estimate the asset’s useful life & the residual value at the end of the useful
life
° Useful life is the periods over which the company will use the asset to
generate revenues.
° Depreciation cost = Acquisition Cost (Capitalized cost) - Residual value ;
-then it must be allocated to the years of useful life, a process of cost
allocation
Depreciation Methods
1. ° Straight-line method allocates the asset’s depreciation cost evenly over
its useful life. -Since assets generate revenues evenly throughout its useful live, this
method matches expenses to revenues
• Rate of depreciation = 1/ # of years; 1/N * depreciation cost.
2. • Production Method/ Units of activity requires that the output or
usefulness that will be derived from the asset be measurable as a specific
quantity. It recognizes the usefulness or benefits derived from the C.A.
Original Cost : $50,000
Estimated R.C. : $500
Usage:
Year 1 2 3 4 5
Unit 4,000 5,000 6,000 4,500 3,000 22,500
Amortization Expense per Unit
= Acquisition Cost – R.V. / Estimated total units of output
= 50,000 – 500 / 22,500
= 2 per unit
-It has no consistent or predictable pattern; depends on actual usage
-Depreciation expense is determined by calculating the deprivation cost
per unit , and multiply this cost per unit by the actual number of units
used
3. • Accelerated or declining-balance method:
Most benefit during early years. This method matches the more rapid
depreciation in the early years of the asset’s life to the revenue.
*Formula: (Acquisition Cost – Accumulated depreciation at the beginning
of period) * Depreciation % = Depreciation expense
* To establish the percentage: • double-declining-balance method:
-Carrying value decreases each year
-Amortization expense decreases each year
-With 40%: the percentage selected is double the straight-line rate;
Year Beginning NBV Beginning D.E. Ending NBV
Depreciation
1 50,000 0 40%*50,000= B.NBV- D.E.=
20,000 30,000
2 30,000 20,000 40%*30,000 18,000
= 12,000
3 18,000 32,000 40%*18,000= 10,800 72,000
4 10,800 39,200 40%*10,800= 6,480